Riskless Principal

What is 'Riskless Principal'

Riskless principal is a trade in a security that involves two orders, with the execution of one of these orders dependent upon the receipt or execution of the other. Riskless principal is defined by the Financial Industry Regulatory Authority (FINRA) as a trade in which a member who has received a customer order immediately executes an identical order in the marketplace, while taking on the role of principal, in order to fill the customer order.

A buy order from a customer would therefore require the member firm to execute an identical buy order in the market as principal, while a sell order would require the member firm to execute an identical sell order in the market. In order to qualify for riskless principal trades, FINRA stipulates that the trades should be executed at the same price, exclusive of a markup/markdown, commission or other fees.

BREAKING DOWN 'Riskless Principal'

For example, a broker-dealer who is a FINRA member and receives a customer order to buy 10,000 shares of Widget Co. at the prevailing market price of $10 would immediately buy the 10,000 shares from another member at $10. Since both trades were executed at the same price (excluding commissions), this would qualify as a riskless principal transaction.

On March 24, 1999, the SEC approved amendments to FINRA, then the National Association of Security Dealers (NASD) rules regarding the reporting of riskless principal transactions by market makers in Nasdaq and OTC securities. The rule change, which was effective Sep. 30, 1999, permitted market makers to only report one leg of a riskless principal transaction, rather than both legs, as was the requirement previously.

While market makers are always deemed to be "at risk" when trading from their principal accounts, the amendment was an acknowledgment of the fact that trades undertaken to offset customer orders are riskless. One of the significant benefits of this rule change was a reduction in transaction fees levied by the SEC.

RELATED TERMS
  1. Continuous Trading

    A method of transacting different securities orders. Continuous ...
  2. Limit Order

    An order placed with a brokerage to buy or sell a set number ...
  3. At The Highest Possible Price

    A type of security trading designation that instructs a brokerage ...
  4. Market Order

    An order that an investor makes through a broker or brokerage ...
  5. Principal Reduction

    A decrease in the principal owing on a loan, typically a mortgage, ...
  6. Trading Ahead

    When a specialist trades securities for his or her own firm's ...
Related Articles
  1. Investing Basics

    Understanding Order Execution

    Find out the various ways in which a broker can fill an order, which can affect costs.
  2. Brokers

    Explaining Market Orders

    A market order is the most common order used to purchase a financial security.
  3. Investing

    How To Start Trading: Order Types

    The types of orders you use can have a large effect on your trading performance, so understanding the different order types is important to your success.
  4. Investing Basics

    Principal Trading and Agency Trading

    Ever wonder what happens behind the scenes when you buy or sell a stock? Read on and find out!
  5. Forex Education

    Intermediate Guide To MetaTrader 4 - Order Types

    Traders have the option of placing different order types using the MT4 platform. Market OrderA market order is the most basic type of trade order and is used to buy or sell a security at the ...
  6. Trading Strategies

    Introduction To Order Types: Duration

    In addition to market, limit, stop and conditional orders, traders can also specify for how long they wish the order to be in effect; that is, how long the order will remain in the market until ...
  7. Professionals

    What The Series 24 Exam Won't Teach You

    Can you handle being the judge and jury in your firm? Find out what surprising tasks a job as a principal entails.
  8. Trading Systems & Software

    Guide to TD Ameritrade's Thinkorswim - Trade Management

    The tools within thinkorswim are for conducting analysis and ultimately making trades. There are many ways to make and manage trades within the platform. This section will go over some of the ...
  9. Brokers

    Brokerage Functions: Underwriting And Agency Roles

    Learning about these various activities can give insight into how securities are issued and traded.
  10. Investing Basics

    Understanding Immediate-or-Cancel Orders

    A trader places an immediate-or-cancel order to immediately execute a trade in full or in part. Any part of the order that remains unfulfilled is canceled.
RELATED FAQS
  1. What is the difference between a stop and a market order?

    Learn about market orders and stop orders, how they are used and executed, and the main difference between stop orders and ... Read Answer >>
  2. Why do limit orders cost more than market orders?

    Learn the difference between a market order and a limit order, and why a trader placing a limit order pays higher fees than ... Read Answer >>
  3. Why is the execution of a limit order not guaranteed?

    Using a limit order to buy a stock can be helpful in securing certain prices, but the mechanics of a limit order can decrease ... Read Answer >>
  4. How can I use a buy limit order to buy a stock?

    Learn how a buy limit order is used by an investor who wants to buy a stock at a certain price, and understand how limit ... Read Answer >>
  5. What is the difference between a stop loss order and a limit order?

    Learn how to manage losses and reduce risk in volatile markets while reviewing the differences between stop-loss orders and ... Read Answer >>
  6. What are the advantages of a limit order over a market order?

    Understand the functional differences between a limit order and a market order and the respective advantages and disadvantages ... Read Answer >>
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center